The curious task of economics…

Russ Roberts, host of EconTalk podcast, often reminds his listeners and his Cafe Hayek blog readers that F.A. Hayek said:

The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.

I think Edward Glaeser did a good job of fulfilling this task in last week’s EconTalk podcast when it comes to nice-sounding government policies that may have unintended consequences of hurting cities.

Here’s one consequence I hadn’t thought of regarding government policies meant to encourage more home ownership:

Having a very pro-home ownership policy also means you have an anti-urban policy, because typically single family houses are owner-occupied whereas multi-family dwellings are rented; on average more than 85% of multi-family dwellings with 5 or more units are rented, exactly the same percentage of households for single-family occupancy being owner-occupied. So if you are going to have federal policy which both directly, through let’s say the home ownership interest deduction, or indirectly, through Fannie Mae and Freddie Mac are going to subsidize owning, you are going to be stacking the deck against high rise houses.

Glaeser also comments on how school districts hurt cities (my parents moved to a suburb when I was a child primarily to get their kids into a better school district):

Now the last thing that artificially stacks the deck against cities is just the way our local education systems work. So, by your telling me your kids like to go tromping around in grass, that’s great; my kids do that. I have no problem with parents making those choices. However, I grew up in the streets of Manhattan and that can also work perfectly well. The problem is that we’ve created such a strong schooling incentive for people to move out of those cities that have weak school systems. I think anything that we can do that tries to somewhat reduces those spacial, those schooling-related, which are fundamentally government-created incentives to suburbanize, that’s probably a good thing.

As I heard Glaeser say this, I was reminded of how Arnold Kling decomposed freedom into having the power of voice and exit. People with bad ideas to use public schools as a means to achieve their desirable social goals took over many public school districts and drowned out the power of voice for many. They didn’t worry about it because public schools were free and they figured that folks would continue to send their kids there. What were they going to do, move?

Yes, that’s exactly what happened. They exercised their power of exit.

The neighborhood I grew up in was a nice, middle class neighborhood. It had been for 40 years from when it was first built. Sadly, it turned into a pit soon after we left. And not because that was the natural order of things. The public education system was failing to educate and that chased people away.

More people wanted out than wanted in. ’Supply and demand’ says that means home prices will go down. When prices fell, folks who couldn’t afford much because they hadn’t made good life choices, or simply didn’t care, moved in. I remember my grandparents finally moving from the home that I believe they bought new when they discovered their next door neighbors were crack addicts willing to do just about anything for their next score.

There are neighborhoods of similar age and design in different parts of the metro area that are subject to different public school systems and they are still thriving.

It’s amazing to me that the very people who love cities so much, the so-called intellectual elites, have done so much damage to them. But, it’s the perfect example of Hayek’s fatal conceit and the curious task of economics.

Russ Roberts on the minimum wage

Russ Roberts had some good recent posts about the minimum wage on Cafe Hayek. The paragraphs below are from his post about his follow-up thoughts to a debate he participated in to abolish the minimum wage:

Everyone, on the left and the right, agree that employers are eager to save costs and will substitute machines for workers or outsource production if those changes are profitable. Why will artificially higher wages created by minimum wage legislation not lead to similar substitutions?

No joke. But, of course, proponents of minimum wage will cite ‘empirical evidence’ that shows that raising the minimum wage has no effect on jobs or employment. And, of course, they never consider that these studies may not tell the whole story or have limitations.

They also seem to forget basic econ where we are taught that if a price floor is well below the going-market rate, it won’t have much affect on supply. In other words, if the minimum wage is well below the going market labor rate, then it won’t have much effect on jobs. For example, if I set a minimum wage at $0.50/hour, most people would intuitively know that’s so low, it doesn’t  effect anyone — employees or employers.

So, while minimum wage studies are often heralded as empirical support for raising the minimum wage, they are much more likely to be empirical support for that basic econ understanding of a price floor.

Next (emphasis mine):

The weird part of the debate over the magnitude of the employment effects, is that when someone uses the reductio ad absurdum of a minimum wage increase to say $50 or $100 an hour, everyone understands that won’t work because it would destroy the labor market. So where do those disemployment effects kick in? If the minimum wage is small enough so that it doesn’t cause job losses, then it can’t be having much of an effect boosting wages.

Yes. Where do the disemployment effects kick in? Great question and I never hear anybody ask it or answer. It’s similar to the ‘rich must pay their fair share’ tax debate where the answer is always ‘more’.

It occurred to me after reading this paragraph that the same people who cite empirical evidence that changes in the minimum wage don’t affect jobs (that price floors below the going market rate don’t change supply), don’t seem interested in asking about empirical evidence that raising the minimum wage actually increases wages.

I suppose they assume that if it doesn’t change the number of a jobs and a few people are marking more now, then wages must go up.  But, that assumes a lot. For example, it assumes other things don’t change — like the number of hours worked and the value of fringe benefits like employee discounts — to name a couple.

“Losses Encourage Prudence”

I wonder if Russ Roberts saw the opinion piece, How to Shrink the “Too-Big-to-Fail” Banks, in Monday’s Wall Street Journal from Richard Fisher and Harvey Rosenblum, who are, respectively, the CEO and Director of Research, at the Federal Reserve Bank of Dallas.

I wonder if Russ Roberts has seen it, because it appears to agree with his hypothesis that a history of government bailout of banks contributed to the financial crisis, because bankers took on more risk than they otherwise would.

Here are Fisher and Rosenblum’s first three paragraphs:

A dozen megabanks today control almost 70% of the assets in the U.S. banking industry. The concentration of assets has been in progress for years, but it intensified during the 2008–09 financial crisis, when several failing giants were absorbed by larger, presumably healthier ones. The result is a lopsided financial system.

Meanwhile, the mere 0.2% of banks deemed “too big to fail” are treated differently from the other 99.8%, and differently from other businesses. Implicit government policy has made these institutions exempt from the normal processes of bankruptcy and creative destruction. Without fear of failure, these banks and their counterparties can take excessive risks.

It also emboldens a sense of immunity from the law. As Attorney General Eric Holder admitted to the Senate on March 6, when banks are considered too big to fail it is “difficult to prosecute them . . . if we do bring a criminal charge, it will have a negative impact on the national economy.”

That last paragraph paints an image for me of the TBTF bankers holding the economy hostage for the taxpayer ransom. I wish I could draw.

Here they sum up the problem rather well:

…market discipline is still lacking for the largest dozen or so institutions, as it was during the last financial crisis. Why should a prospective purchaser of bank debt practice due diligence if in the end, regardless of new layers of regulation and oversight, the issuing institution won’t be allowed to fail?

The return of marketplace discipline and effective due diligence of banking behemoths is long overdue.

In case you are wondering, prospective purchasers of bank debt practicing due diligence is an example of market discipline, just like you practicing due diligence on your car purchase.

Credit Fisher and Rosenblum for going on to offer a solution, which involves rolling back the Federal government safety net and restructuring TBTF banks into entities that can go through speedy bankruptcies so they will be “too small to save”.

I like it. Read the whole thing.

Proposal for new requirements for econ majors

1. Demonstrate that as an economist, you know your limits. As Russ Roberts writes:

Economics isn’t rocket science; it’s a lot harder. We should admit as much and when asked to measure things we cannot measure, we should admit our ignorance.

As an economist, you should be the biggest and best critic of your work.

Even when your work seems airtight, you should caution that you may be missing something.

You should invite criticism of your own work.

When somebody wants to use your work to justify policy positions, you should be warning them, rather than encouraging them.

You should be able to properly identify your own biases and tendencies.

Economists should take an oath similar to the Hippocratic Oath taken by physicians: First, do no harm.

2. Discussion requirements: You should be able to carry out discussions and debates without fallacy.

The persistent use of fallacy in discussion (rather than the occasional and willing-to-admit-it-when-pointed-out use) should be taken as a signal that you place a higher priority on what you believe is true than what is true.

“…it isn’t science”

In case I haven’t mentioned it before, Russ Roberts is on my list of non-pathetic economists. I recommend reading his article, Know Your Limits, in The European Magazine.

This article sums up nicely why Russ thinks we should be more skeptical of economists who are not willing to admit or, worse, aren’t aware of the limits to what they know.

Now You’re Talking

I like some of the latest batch posts that I’ve read on minimum wage.  Here’s a roundup.

1. In this post on the minimum wage on Cafe Hayek, Russ Roberts does a great job articulating a world more complex than any of our models can replicate. True. That’s one reason cost benefit analyses suck. Models are to complex systems as caricatures are to people. They’re nice to hang on the wall, but they don’t talk or anything.

Here’s a sample:

So that when legislation artificially raises price, the debate is over the impact on quantity–how many jobs will be lost (or gained if you’re on the other side.)

But price and quantity are not the only way market forces work. And they are certainly not the only attributes of a job. There is how hard you have to work, how many breaks you get, how much training or mentoring or kindness. What amenities are in the workplace–snack bar, vending machine, nicely decorated walls and so on. When the government requires that wages be higher than what they would otherwise be, that creates an increase in the number of people who would like to work and reduces the number of opportunities available.

2. The Grumpy Economist, John Cochrane, suggests that discussing the minimum wage is “fiddling while Rome burns”, even if the economic magic of raising the minimum doesn’t effect employment were true.

3. Kudos to Russ Roberts’ co-blogger on Cafe Hayek, Don Boudreaux, for his response to a colleague who questioned why he spent so much time writing about the minimum wage:

I protest the legislated minimum-wage because I have a visceral hostility to shabby economics.

Encountering arguments premised on the (typically unconscious) notion that most employers routinely sit on figurative piles of excess profits or returns that can be tapped into by government diktat (“Raise your workers’ wages!”) without any compensating adjustments or reactions by employers makes my head ache.  Encountering otherwise respectable economists performing rococo theorizing in their attempts to explain why unskilled human labor is somehow exempt from the simple application of the law of demand makes my head ache.

Encountering otherwise respectable economists who lend credence, usually unawares, to the person-in-the-street creationist superstition – a creationist superstition held by non-economists on the ideological spectrum ranging from the likes of Harold Meyerson to Bill O’Reilly – that prices, wages, employment conditions, and other economic phenomena are determined arbitrarily, and more or less consciously, by someone in power rather than by decentralized and largely spontaneous market, competitive forces makes my head ache.  Letting stand unchallenged this Meyerson-O’Reilly sense that, therefore, the only question is which powerful group of people will determine prices and wages – the government or the oligarchs? – makes my head ache.

Encountering claims that human welfare can be increased so easily and so surely by mere diktat makes my head ache.

Challenging such claims is the equivalent, for me, of swallowing two aspirin tablets.

What is profit?

I’m looking forward to listening to the latest EconTalk podcast, where an organic farmer talks about profit and how she finds her teenage workers not quite ready to earn their keep. Her theory, similar to mine, is that kids have led a life up to the point of getting their first job where things are done for their benefit, rather than them having to make themselves useful to others.

EconTalk host, Russ Roberts, posted her interesting comments about this here. It’s worth repeating:

we hire some high school kids. And they are lovely people. But usually it’s one of their first jobs, like maybe they’ve mowed the lawn for their neighbor or maybe they did some babysitting. But by and large we’re their first job. So, everything else that’s happened in their life has happened for their benefit. They’ve gone to summer camp–that was for their benefit. They’ve gone to school–that was for their benefit. We as parents certainly do everything we can to benefit our children. And then they come to me and–yeah, there are a lot of programs that go on in the summer. And that’s not what this is. This is: You are going to work, and at the end of the week I’m going to give you money; and I expect that because you are here, I will make more money. And that’s a concept that I’ve had to explain to them. And it comes in really hard. And I have to say: Why would I have you here if I wasn’t going to end up with more money? Why on earth would I have you show up every day? And they kind of start to get that this should be a mutually beneficial arrangement, not just that I shouldn’t come out even because I think of–capitalism as me making money for the aggravation of having you here. And then we get the college kids; they’ve kind of gotten that kind of concept a little better. But then I’ll say: What do you want to do when you are done with college? And they’ll say: Oh, I want to work for a non-profit. And that one makes me angry. First, it’s like, well, non-profit, that could be a hospital, that could be a–like you haven’t thought about this any more–that could be a land trust, it could be anything. ‘Non-profit’ is huge. You don’t have any more direction than that you want to work for a non-profit? But also, they are telling me that profit is bad. So, I say: Well, look around at all this stuff you see, the tractors, the greenhouses, the walk-in cooler–like all this stuff. Ralph and I could have taken that money and even if we put it in the bank in a savings account we’d have earned like a percent or something, even now. But we’ve done this, and we’re risking that–it may not work out; we may not make any money from this; we may not get back the money we put in. Don’t we deserve a little more than what we could get in a bank by doing something safe? And they say: Oh, well yeah, of course you do. And I say: Well, that’s profit. And that’s all that profit is. And: Ohhhh. And then the light dawns. But they come with no idea about how capitalism works, even though capitalism is the economic system of our country.

I’d go a step further on profit.

I think it is unfortunate that we tend to only think of profit as a financial term. This causes us to see differently the actions undertaken by profit-seeking companies from the actions we undertake ourselves to conduct our daily lives. Those evil companies seek profit. How noble I am to give my time to charity.

But, a more general definition of profit is to derive benefit. What percent of your actions do you take to derive benefit?

Why did you show up to work? Probably for the same reason companies distribute their products, to earn money.

Why don’t you devote all of your time to charity? Probably because you need to have a shelter, you need food and clothes and you want quite a few other things. Companies, too, do not give all of their output to charity because they would soon have nothing left to give.

Why did you build the patio and fire-place in your backyard, instead of giving that money to charity? You did this for the same reason companies build lounges for workers and sell their products in pleasant surroundings.

Why did you replace your aging vehicle, instead of giving that money to charity? For the same reason companies replace their aging equipment.

How are the actions you take to derive benefit different from the actions companies take to derive benefit?

There are only two key differences that I see. First, companies more carefully record the money unit benefits of their actions because they have folks who hold them accountable, the owners. Second, they are trying to accrue those benefits for someone else, the owners instead of themselves, unless they happen work for an employee-owned company.

Profit is nothing more than a derived benefit. We profit a great deal from others, that’s why we are willing to pay them. Without that profit, we’d be living the short and lean lifestyle of a hunter-gatherer.

The Will of the People does not exist

As you get older, you learn things aren’t always what they seem. A magician isn’t magical, he’s just highly practiced at misdirection and concealing what’s really happening, for example.

The idea of the Will of the People is similar. We take for granted that majority rule is a fair way to decide things. If the majority wants it, it’s the will of the people and it’s fair. Rarely do we question that.

But, in this week’s EconTalk podcast, Rodden on the Geography of Voting, this idea is put to the test. Near the end, I found the conversation on majority rule and the will of the people very interesting (emphasis added):

[Host] Russ [Roberts]: I think a lot of people have a romance about majority rule. Certainly one way that small groups of people settle disputes is they say: Well, let’s take a vote. And whatever gets the most votes wins. And I think to a lot of people that’s obviously the fairest, best way to decide stuff. And so all of these things that we’ve been talking about that mitigate that–whether it’s the Electoral College, winner take all districts–a lot of people say that’s just not the right way to do things. Everything should be decided by a majority vote. And yet, as we know from work by Kenneth Arrow and others, majority vote in the normative sense, meaning leading to outcomes we like, isn’t so strong as it seems. On the surface, nothing could be fairer than majority rule. And yet when you look a little closer you start to see that majority rule’s got some very deep flaws in it.

Guest [Rodden]: Yeah. This is one of the things that when I teach courses to undergraduates on institutions, we do this in the first or second week. It’s a very easy thing you can do to have the students give their rank ordering of their preferences for what type of pizza that they would like; you have each student rank three and then you put them together. And it’s very easy to find groups of students who have what in the social choice literature is called cycling majorities, where you can show that there is no such thing as the majority will. If I set up the institutions in such a way that there’s first a round robin tournament of pepperoni versus vegetarian and then the winner of that is paired off against sausage, I can get a different outcome than if I do the initial pairings in another way. And so I can show that whoever controls the agenda controls what kind of pizza the students are having. It’s kind of something that we’ve known since Condorcet and Arrow, the classics of social choice theory: it’s simply nonsensical to say that the majority has some kind of will that we will then translate into policy. And so the students are always sort of surprised by this. We like to believe that there is such a thing as the collective will. And I think one of the basic lessons of politics and institutions is, unfortunately, it’s possible to aggregate those preferences in very different ways in different institutions and get different outcomes. So we should[n't] attribute so much importance to something that we believe was the outcome of some kind of majority choice. Often the truth is much more complicated. Agenda control and political power are often used in getting us to the outcomes we see. It leads us to think in a different way about how we interpret the decisions that are made by legislatures and what they actually mean.

Russ: The other problem I have with “will of the people” is majority election. Whether it’s 55-45, or 90-10, the loser obviously felt differently. So it’s not the will of the people. It’s will of those who won that election, whether it’s a majority or whether it’s proportional or whether it’s this weird system we have in the United States. We don’t have referenda on every item. It’s this weird thing called the Legislature, Congress, Senate; we have committees; all this baggage, this incredible superstructure and infrastructure around the way political outcomes are coming out of our preferences. It’s not just a majority rule referendum. But the most important thing to me is that we all have different preferences. And so once you put it into a political process you are basically saying: We are going to get one outcome, and you are stuck with it–because it was the result of a vote. And I don’t see that as necessarily fair at all.

Walter Williams wrote about this, from a different perspective, in his classic Conflict or Cooperation column.

Thomas Sowell also has some excellent thoughts on the topic here .

I like how Russ Roberts finishes the thought in the podcast:

Because political decisions will struggle to reflect anything remotely like the will of the people, I want as few decisions as possible put into that sandbox. I’d rather have the competition of free association and free choice make those decisions and allow for the diversity of outcomes that private markets and private decisions have rather than political decisions, which are inevitably coercive.

Update: Here’s another post relating to the topic: Politics is a group of people making a decision for you.

Spend once shame on you, spend twice shame on us

 

I rarely disagree with Russ Roberts at Cafe Hayek. But I disagree with what he wrote in one of his recent posts:

Many people have excoriated President Obama for suggesting that entrepreneurs can’t claim credit for their success.

It appears that many of these critics have taken the President’s remarks out of context. (Full text here.) Never mind. Even out of context, the critics are wrong and the President is right.

Of course no one creates a business on their own. And yes, government played an important role as the President suggested–creating the schools that educated your workers (often poorly, but I’ll give him the benefit of the doubt), the roads that your product traveled on, the bridges your trucks crossed, etc.

First, I disagree that the critics have taken his comments out of context. The two sentences of the President’s in question are:

If you’ve got a business. you didn’t build that.  Somebody else made that happen.

Adding the full context of his remarks doesn’t change the meaning of these two sentences.

He repeats the same point twice in two sentences. To be in line with the rest of the speech, these two sentences would have looked more like:

If you’ve got a business, you didn’t make that happen all on your own. Others helped you make that happen.

Second, I disagree with Roberts that even with the straightforward meaning of these two sentences, that the President is right. He’s not.

I do believe that we tend oversimplify success and I agree there is usually more to the story than somebody who made it all happen on their own.

But to agree with these sentences, “even out of context”, I do not.

Russ Roberts has written books. Certainly, he couldn’t have done that without the help of a lot of people. The ideas presented in those books were not his own. Russ didn’t make the paper or ink or printing presses. He probably had a copy editor and colleagues who read the manuscript and offered suggestions. And, while writing the book he drove a car made by others, over government bridges and typed on computers built by others.

No disagreement there.

However, without Russ Roberts, those books would not have happened. He DID build that and nobody else made that happen for him. He took all the same inputs available to rest of us and shaped them into something that wasn’t there before and added some value in the process.

I do agree with the key point of Russ’s post, however. Government spending is out of control. This is a problem that needs to be addressed. I don’t like the idea of feeding this problem by taking more from the most productive members of society.

Thomas Sowell stated the obvious here:

Did the taxpayers, including business taxpayers, not pay for that road when it was built? Why should they have to pay for it twice?

Let’s quit busting the balls of successful business people. They pay their share for government and they create products that create value for the rest of us.

It’s inconsistent to bust their balls and complain about lack of jobs at the same time.

It’s time we start holding our government officials accountable. Successful business people are held accountable by their customers. If they make valuable things, customers buy and generate profits. If business folks spend more than the take in consistently, they fail and go out of business.

When government officials spend more than they take in, they whine about the wealthy not paying their fair share so they can take even more from them and spend even more.

Why do we listen to them? Why can’t we look objectively at their spending records and realize they have been woefully irresponsible?

Related articles

• Obama: “I Didn’t Say What You Heard Me Say” (nicedeb.wordpress.com)
• “Tell me at what point other people helping me made me your property.” -David Schmitz (ourdinnertable.wordpress.com)
• Government by Fallacy (ourdinnertable.wordpress.com)

 

“Losses encourage prudence”

George Mason economist and EconTalk podcast host Russ Roberts has said:

Capitalism is a profit and loss system. Profits encourage risk-taking. Losses encourage prudence.

It follows, then, that if you remove losses, you wind up with risk-taking and less prudence.

This removal of losses, and therefore prudence, is a key driver in things like the real estate and mortgage bubble that we are still trying to recover from.

The Wall Street Journal provided a perfect example in this article about a real estate development around a new downtown events arena in Kansas City, Missouri. The city government signed up as partner with a private developer. The city pledged taxes that would be generated from the area to pay off $295 million in bonds issued to help finance the $850 million construction.

Now, with the entertainment center generating about one-third of the original forecast in tax dollars, the city has to cover the bond repayment from its other funds.

Do you believe the private developer would have invested the full $850 million if the City hadn’t agreed to fund $295 million of the construction? Do you think the investors would have been a little more prudent in their investment? Maybe they would have still invested, but perhaps on a smaller scale.

(Thanks to a friend for sending the article to me)